Reserves Up at Home-Loan Agency

The agency's cash reserves have stabilized after dropping sharply over the past two years, according to its annual audit, to be released Tuesday.

The FHA, which guarantees home loans, has seen its business jump in recent years as the government relied on the agency to back more loans—with down payments as low as 3.5%—to shore up the housing market.

The agency guaranteed $931 billion in loans at the end of September, up 36% from a year ago. Three years ago, it guaranteed $332 billion in loans.

The FHA's rapid growth, and a jump in loan defaults, had critics warning it would need government funding for the first time in its 76-year history.

But the agency's latest audit shows modest improvement. The value of FHA reserves rose to $4.7 billion for the year ended Sept. 30, up from $3.6 billion last year but down from $12.9 billion two years ago.

The projected reserves represent 0.5% of all FHA-backed loans, a level unchanged from last year and below the 2% mandated by Congress. If the level goes below zero, the Treasury would have to give the agency a cash infusion.

The FHA's performance exceeded forecasts made in last year's report, although that improvement was offset by technical changes made to more accurately model the insurance fund's finances.
David Stevens,
the agency's commissioner, said he was buoyed by the fact that "we outperformed a report that predicted significant risk at a time when most people were expecting a far worse scenario."

The audit indicates that the FHA won't need a Treasury bailout under current forecasts for home prices. That could change if prices fall more steeply.

"They're still skating on the edge," said
Ann Schnare,
a housing-industry consultant and former Freddie Mac economist.

The audit, prepared by Integrated Financial Engineering Inc. of Rockville, Md., calculates the value of the agency's reserves after estimating 30 years of losses. It relies on assumptions, including home-price declines of 3% over the next year.

The FHA also calculates what would happen to its books if things get worse. If home prices decline 12.5% decline over the next two years, the agency reckons its reserves would fall into the red through late 2011. If prices drop 19%, it would need government funding through 2013.

Some critics say the FHA is taking on too much risk by not raising down payments, but agency officials and other economists say the market could tumble further if it becomes harder to get a mortgage.

"If FHA were to prematurely tighten, the recovery would not happen," said Kenneth Rosen, a professor of economics and real estate at the University of California at Berkeley.

The FHA, created in 1934 to repair markets devastated by the Great Depression, doesn't lend money, but insures lenders against defaults on loans that meet its criteria, collecting fees for that backing.

The agency faded into irrelevance during the subprime-lending boom as private companies offered more favorable terms and, unlike the FHA, didn't require borrowers to document incomes. Prices in many markets rose beyond the limits on FHA-insured loans, effectively shutting out the agency, which in 2006 ensured just 2% of all home loans. Its share had been as high as 15% during the 1990s.

That figure has climbed to about 25% today as several lenders making subprime loans to borrowers with poor credit went out of business and then as government-backed mortgage investors Fannie Mae and Freddie Mac, stung by rising losses, raised fees and tightened standards. FHA-insured loans made in 2007 and 2008 have performed terribly.

Agency officials say they have no desire to continue playing such a large role. "Having FHA do this much volume is a sign of a very sick system," Mr. Stevens told an industry audience in May. "It was sick when it was 3% of the market, and it's sick today."

The FHA owes its improving fortunes to two broad developments. First, banks that originate FHA-backed loans two years ago began tightening their standards beyond what the agency requires. As a result, loans made in 2009 and 2010 are expected to perform well.

Second, officials instituted a series of measures after last year's audit showed just how quickly the agency's finances had deteriorated. They mostly resisted calls to raise minimum down payments and instead revamped insurance premiums and ejected lenders with spotty track records. Higher insurance premiums were designed to boost reserves, but could also help push business back to private players.

Other hurdles remain, including a federal bureaucracy than can hamper quick action. For example, the FHA announced plans in January to reduce the amount of cash that sellers could kick in for closing costs on loans it would insure, after studies showed those loans performed badly, but it still hasn't finalized the policy.

"The problem is not that they haven't diagnosed these problems, but that they've been unable to respond in a rapidly evolving market," Ms. Schnare said.

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